Becoming an adult means taking on new responsibilities. Many of those responsibilities involve money, and part of your financial responsibility is building credit. Paying cash for everything has a certain appeal, but if you see a house or a car anywhere in your future, you will need to pay attention to your credit score. The sooner you start building credit, the better.
There’s a bit of a catch-22 involved in building credit. You can’t build credit without using credit, and you can’t get credit without establishing credit first. That sounds like an impossible situation, but it’s not. There are many ways to start building credit, and you can start sooner than you think. Use these tactics to help you establish your credit, and you’ll be ready for all the adulting you can handle.
1. Understand Credit
Before you start building credit, you should know what you’re building. You don’t need to become a personal finance expert, but you should at least be familiar with what a credit report is, what a credit score is, how information gets to your credit report, and how the information in your credit report is used to generate a credit score. This information will help you plot your credit-building strategy and avoid mistakes that could damage your credit.
2. Start With a Credit Card
Using a credit card is one of the fastest ways to build your credit, but getting a conventional card is a bit tricky when you don’t have a credit score. Credit card issuers understand this, and they have designed ways for you to build the credit you need. They want new customers and it’s in their interest to help you build the credit you need.
Become an Authorized User
If you don’t think you’re ready for a credit card of your own, consider becoming an authorized user on someone else’s card. Typically you ask to be an authorized user on a family member’s card.
To get the maximum benefit as an authorized user, confirm that the credit card issuer reports the payment history to all three credit bureaus for anyone with access to the card. Some issuers don’t report authorized user activity, so confirming this is essential. If the card issuer does report to all three, then being an authorized user will start building your credit file.
Student Credit Cards
As the name implies, a student credit card is designed for college students or young people of college age. Most card issuers offer these products and they are a great choice when trying to build your credit. Some cards may require that you be an enrolled student, others may not.
Student credit cards are geared towards people 18 years of age or older. Some may only be available if you’re over 21. If you do not have income then a co-signer for your card may be required. Look for student credit cards with reward programs and cash back opportunities. You won’t have to pay a deposit and the card works the way a typical credit card does.
Secured Credit Cards
If you don’t meet the criteria for a student credit card, consider a secured credit card. You’ll pay a deposit and the amount you deposit becomes your credit limit. You are free to use the card anywhere, in the same way you would any other credit card.
Typically secured credit cards have higher interest rates, but the benefits are still worth it. Remember that if you pay your balance in full on or before the due date every month, you will pay no interest at all.
Some secured cards offer no or low annual fees, and some even offer reward programs. Look for a card that reports your payment information to all three credit bureaus (Experian, Equifax, and TransUnion). That will help you to build your credit faster.
Store Credit Cards
If you often use a particular retail store, consider a store credit card. Qualification is usually relatively easy. These cards will help you build credit, but they tend to have higher interest rates and lower credit limits than other cards, and you can only use them in the store that issued the card. These cards do report to the credit bureaus, so you will start building a credit record.
Use Your Card Wisely
A credit card can be a great way to build credit, but if you’re not careful it can also hurt your credit. Remember that you will pay no interest if you pay your entire balance on or before the due date. That’s a free loan, and it’s a great deal for you. If you carry a balance beyond the due date you will pay a very high interest rate, compounded daily. That’s a great deal for the card issuer and not a great deal for you. Always pay your balance in full and on time, and always try to keep your balance below 30% of your credit limit.
3. Use a Loan
Your credit mix contributes to your credit score. You’ll build credit faster with a mix of revolving credit, like credit cards, and installment credit, like a student loan. A loan can help you finance critical expenses and build credit at the same time.
Student loans, whether federal or private, are reported to the credit bureaus. Of the two, Federal loans do not require a credit check, which makes them an easier place to start. Even if you don’t need a loan to finance your education, it may be worth taking out a small federal loan just to help you build credit. The current interest rate on undergraduate federal student loans is under 3%, and that interest rate with no credit check is a deal you won’t find anywhere else.
Private loans require a credit check and proof of income, so it may be harder to qualify without a co-signer. Your payment record on both federal and private loans will be reported and will show on your credit report within a few months of loan activation.
Another loan option is a credit-builder loan. Many banks and credit unions offer these products. The lender places the money in an interest-bearing account. You make the payments, and the lender reports them to the credit reporting agencies. When the loan is fully paid, you get the entire sum with any interest it has accumulated. That lump sum is a great incentive to make the payments!
Credit builder loans involve little or no risk to the lender because the lender holds the money until the loan is fully paid. Because there’s so little risk, lenders may approve these loans even for clients with no credit score, especially if the client is an existing customer. Ask at your bank or credit union.
4. Get a Co-Signer
If you have a hard time getting approved for a credit card or loan, a co-signer can swing the deal in your favor. A co-signer is a person with established credit, often a parent, who agrees to take responsibility for any part of the debt you do not pay.
Be sure that both you and your prospective cosigner understand the responsibilities and potential implications of cosigning. Research indicates that 40% of cosigners end up paying some portion of the debt they sign for. If you mismanage your loan or credit card your cosigner’s credit could be affected, and even if you don’t, your debt will be included in your cosigner’s debt-to-income ratio, which could affect their creditworthiness.
5. Get Credit for What You Pay
Another way to build credit is to have payments you make on a regular basis added to your credit profile. You may be able to get regular expenses like your mobile phone bill, rent, and utilities included in your credit report. You have to pay them anyway, so you might as well gain from them.
A good example of this is the popular Experian Boost program. It connects to your bank account to look for regular utility payments. This information is added to your Experian profile and, as the name suggests, can boost your credit score. eCredAble Lift is another similar program, but it only reports to TransUnion. You link your account and you’re able to get credit for phone, utilities, and rent payments.
Another service to boost your score for rental payments is Experian’s RentBureau. This is the same concept as the Boost program, but it’s specifically for rental payments. If you’re signing a lease or already have one, ask if the property management company reports to RentBureau. If they do, then one of your credit reports (Experian) is updated with your rental payment history.
The downside to these options is not all credit bureaus receive your payment history. You can still boost your thin credit profile by making routine payments on time.
When to Start Building Credit
Many young people don’t think much about credit, and a credit card or loan often seems more like an obligation than an asset. For most people, though, somewhere between 18 to 21 is the right time to start. Establishing your credit early, and remaining responsible with your credit, can make your life easier in a whole range of situations. Credit makes a difference in many activities, for example:
- Applying for your first job
- Submitting a rental application for an apartment, house, or condo
- Getting a cell phone put in your name
- Having utilities established in your name
- Lower, more competitive interest rates on an auto loan
- More competitive interest rates on a credit card
- Renting a car
- Qualifying for a corporate credit card
Starting to build credit is important, but it’s not enough. Maintaining your credit score is as important as building it. Having a strong credit score improves your chances of approval for future loans and reduces the amount you pay on interest rates for loans and credit cards.
Pay Your Bills On Time
Paying your bills on time is a key part of maintaining and improving your credit. Each month, lenders send payment information to the three credit bureaus. Your payment is recorded either as on-time, 30 days late or more. This information is the single greatest influence on your credit score.
Even if a biller doesn’t report to the credit reporting agencies, it’s important to keep your accounts in good standing.
Don’t Close Accounts
It seems counterintuitive to be dinged for closing a credit card. After all, it should signal to the credit world you no longer need credit. The credit bureaus and lenders look at it a different way, and closing an account can put a dent in your credit.
There are several reasons why this happens. If you close an older account, the average length of your credit history will be reduced, which can affect your credit score. The diversity of your credit mix may also be reduced. Closing a credit card will reduce your total credit limit, and that can raise your credit utilization. Credit utilization is simply the percentage of your total available credit that you are using.
Check your Credit Report
Monitoring your credit is an essential part of responsible credit management. It’s important to review your credit score and your credit report on a regular basis. Not only does it keep you in the know about what’s being reported, but it helps you spot mistakes. The FTC once estimated one in five credit reports contain an error. You are your only advocate, so if you see an error you have to take the steps to get it corrected. The only way to spot this is by regular monitoring.
Fortunately, this is easier than ever. Many banks or credit cards offer a free credit score review as a perk. Simply sign up and you get a snapshot each month. You are also entitled to three free credit reports per year through AnnualCreditReport.com, and it’s a good idea to get in the habit of ordering them and reading them carefully.
Your credit score has a significant influence on your life, and the earlier you start building it, the more it can work for you. Understand where your credit score comes from, build it one step at a time, and the day will come when you’re glad you did. Remember, the time to start building your credit is well before you need it!
What’s your #1 way to start building credit? Let us know in the comments!